Forward exchange rate

Forward exchange rate

Forward Foreign Exchange Rate

The agreed-upon exchange rate for a forward contract on a currency. When a forward contract is made, the parties agree to buy/sell the underlying currency at a certain point in the future at a certain exchange rate. The rate is negotiated directly between the parties, unlike a futures contract, which trades on an exchange. Partly because there is little secondary market for forward contracts, determining the forward foreign exchange rate is a zero-sum game: one party will gain on the contract and one will lose, depending on the movements of the relevant currencies between the formation of the contract and its maturity.

In short, the above IRP equation says that the short term investment (or borrowing) in the domestic money market must be equal to the short term investment (or borrowing) in the foreign money market, then sold (or bought) forward for the home currency at forward exchange rate F to lock in the investment (or repayment) values.

5) The 'puzzle' is why does the forward exchange rate (that is, the exchange rate quoted today for the delivery and payment of funds on a future date) give biased forecasts of the spot exchange rate that will occur on the settlement date.

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